What’s the Big Deal?
At the time of writing, the S&P 500 index sits about 1% from its all-time high that was reached in February of this year. If the S&P breaks that mark, it will have taken Wall Street a mere 5 months to digest a global pandemic – a strong display of both the unpredictability and forward-looking nature of the capital markets. With each record high, a wave of amnesia falls over the financial media; they begin to place undue emphasis on these arbitrary levels as if they are indicators of future events. Why make such a fuss?
Perhaps much of the unwarranted attention given to these events arises from the uncertainty around what comes next. We’ve just hit the high, are we in for another 5 years of rising markets? What about a correction? Should I get out now and wait to see what happens if a wave 2 comes? The unknowability of these questions makes for great headlines and is naturally a source of anxiety for many investors, but it doesn’t have to be.
Average Annualized Returns After Market Highs of the S&P 500, 1926-2019
History has shown that the experience for an investor in the subsequent 1,3, and 5 year periods after a market high has yielded great returns. Does that mean it will happen once the next market high is broken? We can’t be sure; however, 93 years of historical data would suggest positive returns are likely. Rather than focusing on the numbers, we can think about it using fundamental rules of capital markets.
Why do you invest your savings into the global stock market? Hopefully, it’s because you recognize that each day, stocks have a positive expected return to compensate people for bearing certain risks. At any given time, the price of a stock or market index like the S&P 500 reflects the value of future cash flows expected by buyers and sellers. If buyers believe that there is more uncertainty around the receiving of a stock’s future cash flows, they will want to pay a lower price for that stock. Buyers will only transact when the price reaches a level where they expect to earn a positive return. It is because of this that we trust stock market prices to be set to a level at which the expected rate of return for investing is positive, regardless of whether markets are at an all time high or not.
If by the time you’re reading this, the S&P has broken its previous high or is hovering somewhere just below it and that omnipresent question creeps into your head, “is now a good time to be invested?” remind yourself of the following: we tune out the financial media because it just unnecessary noise, we let the markets work for us rather than trying to guess where they’re headed next, and we understand that the current price represents a point in time at which expected returns are positive, records be damned.